PHILADELPHIA - The story behind a state’s rainy day fund should be weighed heavily when determining credit quality, according to some municipal analysts.

“If a state is choosing to use its rainy day fund we’re going to want to understand what other options were available did they consider,” said Moody’s Investors Service analyst Baye Larsen at Thursday’s Philadelphia Municipal Analyst Society meeting. “Are they just tapping the rainy day fund or are they also cutting spending? Are they also looking at revenue raising opportunities? Are they really trying to tap into all sides of the budget and come up with a comprehensive plan to weather this downturn?”

Moody's analyst Baye Larsen (far left) discusses importance of rainy day funds on state credit conditions with Vanguard investment analyst Erin Kelly and Dr. Jon Moody, a research fellow at Pew Charitable Trusts.
Moody's analyst Baye Larsen (far left) discusses importance of rainy day funds on state credit conditions with Vanguard investment analyst Erin Kelly and Dr. Jon Moody, a research fellow at Pew Charitable Trusts. Andrew Coen

Larsen noted that the size of a rainy day fund can offer some insight into a state’s “political priorities” and “willingness to make difficult choices” that will indicate its fiscal direction.

She said, for example, states sometimes preserve rainy day funds at the expense of other priorities such as making full pension contributions, creating long-term consequences that will ultimately harm credit conditions. Rainy day fund policies vary greatly among states with Missouri against tapping into its reserves while Oregon and Ohio have long track record of utilizing the funds in times of need and then replenishing.

“If you are withdrawing from your rainy day fund during a down cycle when your revenues are at a temporary low, you’re not necessarily damaging your structural balance because in theory those revenues post-cycle will go back up and you can begin to restore your rainy day fund,” said Larsen.

Dr. Jon Moody, a research fellow at Pew Charitable Trusts, presented at the meeting recent studies his team has produced about how states are approaching rainy day funds as they brace for the next recession. A panel discussion then followed moderated by Brenna Erford, director of retirement policy at the Arnold Foundation featuring Dr. Moody, Larsen and Erin Kelly, an investment analyst at Vanguard.

“Withdrawals during recessions will not necessarily jeopardize credit ratings as long as other budgetary actions are taken,” said Moody. "States should base their decision to tap the rainy day fund on the fiscal situation and rather than worrying about the credit implications they should identify that this one tool among many to then help them.”

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